Withholding requirements for partnerships with foreign partners.

• Author: Nazir, Sadia

On May 13, 2005, the IRS issued final and temporary regulations under Sec. 1446 (TD 9200), which contain new rules affecting the withholding requirements for partnerships with foreign partners.

Final Regs.

The final regulations provide guidance for partnerships required to pay withholding tax under Sec. 1446. They permit a partnership to consider the character of income or gain allocable to a foreign partner in applying the highest rate applicable to that type of income or gain. For example, to the extent that long-term capital gain is allocable to a noncorporate foreign partner, a partnership may withhold tax by using the highest capital gain rate (currently, 15%). Also, the final regulations prohibit a partnership from using a preferential rate in computing the Sec. 1446 tax on income or gain allocable to a foreign partner if such rate depends on whether the partner's status is corporate or noncorporate, and if either the (1) status was not documented or (2) regulations require withholding at the highest applicable Sec. 1446(b) rate.

The final regulations clarify that a domestic upper-tier partnership (UTP) may elect to have the Regs. Sec. 1.1446-5 lookthrough rules apply, permitting a lower-tier partnership (LTP) to look through the UTP. The LTP is required to consent in writing to this election.

The final regulations also (1) relax the notice requirements for partnerships with 500 or more foreign partners, (2) clarify when a partnership be deemed to have paid Sec. 1446 tax under the deemed-payment rule, (3) contain special rules for domestic and foreign estates and trusts and (4) fine-tune many provisions in the 2003 proposed regulations (REG-108524-00, 9/2/03).

Temp. Regs.

The temporary regulations permit certain foreign partners to certify deductions and losses to a partnership, to reduce the Sec. 1446 tax the partnership has to withhold on their allocable effectively connected income (ECI). A foreign partner choosing to certify its losses and deductions must submit a new certificate for each partnership tax year. A foreign partner can only submit a certificate if it has submitted documentation to the partnership establishing that:

1. It is in compliance with Regs. Sec. 1.1446-1;

2. It filed or will timely file U.S. income tax returns for each of the preceding four tax years and for the tax year for which it filed the certificate; and

3. The tax corresponding to these fillings was or will be timely paid.

Certificates must be submitted...